Hello all!
I took out a business loan in 2018 of $1.5M, which was 5.5%. The balance is around $450K, so the interest is 11% as of today. I reached out to our lender, and they are willing to shave off .25%, which is nothing, and option two is to lower the payment by adding an additional ten years. So, interest will accumulate. The payment will go in half or even lower. I will carry a long-term debt. But I can make a larger payment toward the principal and free up some cash flow when I have large sums of money. Business is doing well, and I can make the current payment with no problem, but watching so much cash flow going towards interest and payment is not sitting well with me. Also, my debt ratio is good; unfortunately, SBA products are hard to convert to traditional loans. So basically, my bank is saying hey, look, there is a way to lower your payment, but you will pay more interest when all is set and done. I told them I might sell the business one day before the date and could walk away with the asking price and valuation.
I really don’t know what to do. I can make monthly payments with no problem, but it’s just insane to watch 11% toward interest. If I take the lower payment road and let them review my statement, etc., I can free up some cash.
Extend term if no prepayment penalty and continue making same payments you are.
You pay down loan faster bc excess payment will go to principal. You’ll also have more breathing room to invest in other areas given lower payment if you choose. Also having more time to potentially refinance if rates come down in next few years.
Source: CFO adviser to multiple businesses in my area with focus on capital markets and capital structure.
How does this work? If you extend the terms, doesn’t more go to interest in the beginning?
Interest accrues on the outstanding balance monthly. If the rate is the same on both options, you will pay the same amount of interest in the first month. The difference in total interest paid results from the lower payments - when you stretch the amortization over a longer period to lower the payment, you pay off less principal with each payment. The next month, your outstanding principal balance is higher in the longer term option, so more interest is charged.
If you’re wanting to reduce the total interest paid, you have to pay down the principal faster by paying more than your minimum payment, or reduce the interest rate. If you’re wanting to lower the total payment amount (size), then extending the amortization will lower your minimum payment, but will increase the amount of interest paid in total over the life of the loan.
If you extend the term at the same rate, your minimum payment will be lower, but as long as there’s no prepayment penalty, you can pay excess cashflow toward the principal to reduce the balance and the interest charged in the future. This lowers your leverage to cushion downturns but also holds your total interest paid at the same amount your initial loan if you continue the same payments.
If you’re wanting both a lower payment and less interest charged, you will have to refinance into a loan with a lower rate. Good luck doing that right now. WSJ Prime is 8.5%, and most loans will be a spread over that. Money was artificially free for the last few years. This is no longer the case.